Retreating from this critical network for greening global finance signals a worrying neglect of the very real risks that climate change and environmental degradation present for macroeconomic and financial stability in the United States – risks that fall squarely within the Fed’s mandate, write Joseph Feyertag and David Barmes.

Several days ahead of Donald Trump’s reinauguration as American President, the U.S. Federal Reserve announced its withdrawal from the Network for Greening the Financial System (NGFS). The Fed’s board justified its decision on the basis that the NGFS’s scope had drifted into areas that fall “outside the Board’s statutory mandate”. But the Fed’s decision seems to contradict its own rationale for joining the NGFS just a few years ago, and its subsequent work on environmental risks to financial and macroeconomic stability.

Financial stability risks

Although the Federal Reserve was established in 1913 following a string of banking panics in the US, financial stability has never been part of its primary mandate. Even its emergency facilities during the 2008 Global Financial Crisis were justified for the purposes of effective monetary policy transmission.

Instead, the financial regulatory space in the US is populated by several bodies, including the Treasury’s Financial Stability Oversight Council (FSOC) and the Office of the Comptroller of the Currency (OCC). The OCC remains, at the time of writing, a member of the NGFS, along with US securities regulators such as the Federal Housing Finance Agency (FHFA), the Federal Deposit Insurance Corporation (FDIC) and the Federal Insurance Office (FIO). Although it is not a member, the FSOC has previously stated its participation in “international work on climate-related financial risk” on the basis of the Fed’s NGFS membership.

The Fed itself formally joined NGFS in December 2020, when Chair Jerome Powell stressed the central bank’s intent to deepen its “understanding of how best to assess the impact of climate change on the financial system”. In subsequent years the central bank stepped up its work on climate-related systemic risks in its Financial Stability Reports. Fed researchers have also examined the growing impact of extreme weather on financial stability, particularly within the insurance sector, as well as giving several speeches addressing the financial stability implications of climate change.

The NGFS has thereby played a critical role in the mainstreaming of analysis on climate and environment-related financial risks, not just in the US but around the world. The NGFS’s work has since broadened out to more explicitly encompass wider ‘nature’-related financial risks beyond climate, such as those relating to biodiversity loss. This may stretch outside the Fed’s comfort zone, but there is little use in attempting to understand and manage the financial implications of climate change without grappling with the growing body of research that documents the interconnected risks relating to the breaching of various other planetary boundaries. While major central banks and organisations such as the European Central Bank, the Bank of England and the Financial Stability Board increasingly accept this reality, the Fed will now miss out on relevant knowledge-sharing and collaboration under the auspices of the NGFS.

Employment risks

Against the backdrop of high inflation and unemployment, a 1977 amendment to the Fed’s mandate introduced maximum employment and price stability as its core monetary policy objectives. While all central banks grapple with the interplay between price stability and (un)employment, using concepts such as the Phillips Curve, the Beveridge Curve and the Non-Accelerating Inflation Rate of Unemployment (NAIRU), the Fed’s ‘dual’ mandate is almost unique in placing employment on an equal footing with inflation. Among other major central banks, only the Reserve Bank of Australia has a similar dual objective.

A disadvantage of the dual mandate is that it presents monetary policy trade-offs, especially during supply shocks such as energy price spikes, which put pressure on both unemployment and prices. However, the Fed was able to focus almost exclusively on controlling inflation by tightening monetary policy in the aftermath of the COVID-19 pandemic given historically low levels of unemployment in the US. As a recent Treasury report highlighted, labour force participation has reached record highs and unemployment historical lows, and real wages have grown, particularly for low-income workers and despite inflationary pressures.

This robust performance owes much to proactive fiscal policy, including landmark legislation such as the Inflation Reduction Act (IRA). As well as spurring economic recovery, these measures have laid the groundwork for a low-carbon transition. But here is where labour market risk looms large. Along with an abolishment of the dual mandate, the policy blueprint for the new Trump administration, Project 2025, calls for the repeal of green energy subsidies under the IRA, withdrawal from international climate agreements, and increased investment in fossil fuels. Some of these plans have already been enacted, through a string of executive orders made shortly after Monday’s inauguration. They will place the US firmly on a ‘delayed transition’ path, exacerbating unemployment as fossil-based jobs decline and low-carbon technologies gain market dominance.

Although its initial focus was on climate-related financial risks, recent NGFS research has explored the macroeconomic impacts of climate change and environmental degradation. Contrary to the Fed’s given reason for leaving the NGFS, this shift has in fact moved towards the Fed’s explicit policy mandate to cover employment as a growing topic of inquiry. For instance, the NGFS’s updated scenarios include unemployment projections, and reveal a sharp rise in joblessness under delayed transition pathways (see Figure 1).

The risks are compounded by the growing economic toll of extreme weather events in the form of heatwaves, wildfires and hurricanes as they become more frequent and severe due to climate change: these disasters are reducing labour supply, destroying infrastructure and dampening labour demand. For instance, this month’s wildfires in California are expected to cut job creation by up to 40,000 jobs in January, likely followed by a sharp spike in demand for workers in sectors such as construction. It is puzzling that the Fed would exit the NGFS just as these macroeconomic implications are becoming a central focus for the network.

Figure 1. Absolute change in unemployment in the US under NGFS climate scenarios (Global Change Analysis Model 6.0)
Price stability risks

The NGFS has also increased its emphasis on the implications of physical and transition risks for price stability; mitigating these risks is the core objective of all central banks in modern times. Emerging literature suggests that climate change and interconnected crises may become a source of increasingly frequent and severe supply shocks that disrupt macroeconomic stability and complicate central banks’ efforts to maintain price stability without harming other economic, environmental and social objectives. While transition policies may also produce inflationary pressures in the short to medium term, a successful green transition is a prerequisite for long-term price stability. A delayed transition would severely amplify risks to price stability, increasing the exposure of the US to economic shocks of the kind witnessed in recent years.

Former Vice Chair of the Fed Lael Brainard is one of the few senior central bankers to have explicitly highlighted this risk, stating that “longer-term changes – such as those associated with labor supply, deglobalization, and climate change – could reduce the elasticity of supply and increase inflation volatility into the future”. This may become one the Fed’s biggest challenges in the coming decades, and the NGFS’s work on the climate-related piece of this puzzle could be of critical assistance in understanding and navigating these dynamics. The Fed may view the distinct though related discussions on the greening of monetary operations as stretching beyond its mandate, but this is no good reason to isolate itself from investigations of the implications of climate change and environmental degradation for the appropriate monetary stance and framework.

The future of the NGFS and the Federal Reserve

The NGFS will have greater freedoms without the Fed. It can continue to broaden its scope to explore the impact of climate change and environmental degradation on financial and macroeconomic stability, and how central banks and supervisors can address this impact. But contrary to the Fed’s assertion that the NGFS has excessively broadened its scope, the network’s latest research focusing on the macroeconomic implications of climate change is of the utmost relevance to the Fed’s dual mandate. By leaving the NGFS, the Fed also risks falling further behind on supporting the interoperability of standards, keeping pace with emerging best practice, and avoiding market fragmentation.

Just as the Fed’s decision to join the NGFS in 2020 aligned with political currents, its departure more reflects a shift in the US political landscape than any deep concern about the NGFS’s scope. As Chris Giles put it in the Financial Times, the Fed’s strategy is clear: “Hug the statutory dual mandate of price stability and maximum employment tight, while bend with the wind in less important areas.”  But the NGFS remains 140-plus members strong, and will no doubt continue developing its important and influential work.

We can only hope that the Fed will also continue to do its part, even if in a more quiet and isolated fashion, to understand and address the growing implications of climate change and environmental degradation for its objectives of price stability, maximum employment and financial stability. Failure to incorporate these impacts risks eroding the efficacy of monetary policy and the ability of supervisory practices to ensure the safety and soundness of financial institutions – not just in the US, but around the world. Economic and environmental stability depends on the Fed prioritising science over politics.